No taxes on tips: What you need to know for 2026 and 2027

Thanks to the One Big Beautiful Bill Act (OBBBA), tipped workers can deduct qualified tips from their federal taxable income, up to $25,000 a year.

The law was passed back in July 2025 with a proposed list of qualifying jobs, and in April 2026, the IRS finalized the rules that determine exactly who qualifies and how the deduction works. Because of this, there’s a lot less guesswork heading into the 2026 tax year and the 2027 filing season than there was in the deduction’s first year.

To help you join the 80% of small business owners who feel confident preparing their business for tax season, we’ve updated this guide to reflect the IRS’s finalized rules and address common misconceptions about how this deduction affects paycheck withholding.

What is the "no tax on tips" provision?

The “no tax on tips” deduction comes from a new section of the tax code created by OBBBA, signed into law in July 2025. With this temporary federal income tax deduction, eligible employees and self-employed workers can deduct up to $25,000 of qualified tips from their taxable income each year.

This deduction has applied since January 1, 2025, so tax year 2025 (filed in early 2026) was the first year workers could claim it. It’s in effect through the 2028 tax year, and Congress may extend it further.

For its first several months, the IRS was still working from a proposed list of qualifying occupations and a proposed definition of “qualified tips.” Those propositions became final regulations in April 2026.

Who is eligible for the tip deduction?

The definition of “qualified tips” is tips that meet both of the following criteria:

• Paid voluntarily by the customer (not negotiated, and not a mandatory service charge or auto-gratuity)
• Paid in cash or a cash equivalent (including credit and debit cards, gift cards, and mobile payment apps)

Note: Tips paid in cryptocurrency or other digital assets don’t qualify.

The “no tax on tips” deduction is only available to those who work in occupations that “customarily and regularly” receive tips, plus a handful of other requirements determined by the Treasury Department.

In April 2026, the IRS finalized a list of more than 70 qualifying tipped occupations. The final list added a few occupations that weren’t in the original proposal, including floral designers, visual artists, and gas pump attendants. The occupations are organized into eight categories:

• Home services
• Personal services
• Entertainment and events
• Recreation and instruction
• Beverage and food service
• Transportation and delivery
• Hospitality and guest services
• Personal appearance and wellness

Eligibility requirements

The “no tax on tips” deduction applies to federal income tax only and is available for tax years 2025 through 2028.

In order to qualify for the deduction:

• The occupation must be one of the 70+ that the IRS lists as customarily receiving tips, like waitstaff, bartenders, and hairstylists.
• Tips must meet the above definition of “qualified tips” (paid voluntarily by the customer, and paid in cash or a cash equivalent).
• Tips must be reported on a W-2, 1099, or Form 4137.
• The worker must have a work-eligible Social Security number.
• Married filers must file a joint return to claim the deduction.

Remember: whether tips qualify depends on the employer’s line of business, not just the worker’s job title. If you work for (or are self-employed under) a Specified Service Trade or Business (SSTB) (in categories like law, accounting, consulting, athletics, and financial services), your tips don’t qualify for the deduction, even if your role is on the qualifying-occupations list.

Income limitations

The new tip tax deduction does come with some income limitations and phase-out rules. The MAGI (modified adjusted gross income) caps are:

• $150,000 for single filers
• $300,000 for married filing jointly

Above these income amounts, the deduction will begin phasing out and will zero out at:

• $400,000 or single filers
• $550,000 for married filing jointly

This particular deduction is available to both people who take the standard deduction and people who itemize their deductions.

The maximum annual deduction (per individual) is $25,000. However, for self-employed taxes, there’s an added rule: The deduction cannot exceed net income from tip-based work.

So if you made $40,000 with half that being tips, but you had $25,000 worth of expenses, you’d only be able to deduct $15,000 of your tips instead of the full $20,000.

How does the deduction work?

Throughout the year, employees must report their tip earnings to their employer at least once a month. Employers then need to submit this income information to the IRS on the employee’s W-2.

At tax filing time, eligible employees and self-employed workers claim the deduction on the new IRS Schedule 1-A attached to Form 1040, deducting up to $25,000 of qualified tip income from their taxable income for the year.

Let’s take a look at an example scenario on how to calculate taxes on tips with the new rules:

Sarah is a hair stylist who earns $40,000 per year, including $8,000 in tips. Below is what her tax bill would have looked like before the deduction, versus how it looks now with the new ‘no taxes on tips’ deduction.

Sarah’s paycheck withholding doesn't change during the year. Her employer keeps withholding federal income tax on her tips the same way they always have. The savings above will show up when she files her return and claims the deduction, not in a bigger paycheck throughout the year (unless she chooses to adjust her W-4—more on that below).

Federal income tax vs. other taxes

The deduction only impacts federal income tax, so tips are still fully subject to Social Security, Medicare, and state/local level taxes. These will be withheld from your tips, no matter how much you earn.

It’s a common point of confusion, but this deduction doesn’t change how federal income tax is withheld from paychecks. Employers withhold federal income tax from tips the same way they have in the past, based on the employee’s Form W-4 and the withholding settings in their payroll software. There’s no special rule that exempts the first $25,000 of tips from withholding. The deduction doesn’t reduce taxable income when the tips are earned, only when the employee files their return and claims it.

An employer that stops withholding federal income tax on tips under $25,000, assuming they’re now tax-free, would be under-withholding, which can leave the employee with a surprise tax bill (and potentially an underpayment penalty) at filing time.

Another added benefit of the deduction is that it reduces taxable income, which could result in a lower tax bracket and even more tax savings. Employees who’d rather see the expected savings in their paycheck sooner, instead of waiting for a bigger refund or lower balance due at filing, can submit a new Form W-4 and adjust their withholding using the IRS’s Tax Withholding Estimator. But that’s an election the employee makes, not something that happens automatically.

Reporting requirements for workers

To take full advantage of the deduction, tipped employees must maintain meticulous records. Starting a daily log may be helpful.

Per IRS requirements, any tips a person earns, whether via cash, check, or credit card, must be reported to their employer no later than the 10th of the following month. This will ensure tip income is recorded accurately on W-2s or 1099s.

Starting with tips earned in 2026, employers must also separately report:

• Each employee’s occupation using a three-digit Treasury Tipped Occupation Code in Box 14b
• Each employee’s total qualified tips in Box 12 (code TP), on Form W-2

This information flows into the employee’s Schedule 1-A at filing time.

Employees who are unable to report tips earned to their employer can use Form 4137 to calculate Social Security and Medicare taxes owed on their tips. This form should be attached and sent in with their tax return.

Do employers pay payroll taxes on tips?

Employers will have to pay their proportion of FICA taxes on the tips that employees report.

To ensure that employees can claim the full tip deduction amount, employers will need to accurately report tips earned on all employee W-2s and on contractors' 1099s, including the new occupation code and qualified-tip breakouts. This will require the separate tracking of wages paid and tips. If your current system can’t support this, you may need to adjust or upgrade your accounting solution.

With the new deduction, it may also be helpful to allow employees to adjust their W-4 withholding so that they aren’t overpaying their taxes. Keep in mind this is an employee choice, not something employers need to do automatically on their behalf.

Aside from business taxes, the change in tax law may impact other areas of your business, like hiring, retention, employee classification, and customer satisfaction.

For instance, according to the IRS, charges such as automatic gratuities and service charges are not considered tips. That distinction matters for this deduction because if customers don’t have a voluntary choice about the amount, then those payments won’t qualify. This can make accurately tracking tips harder, affect how much of your team’s take-home pay benefits from this deduction, and even warrant a revision to existing tipping and service-charge policies.

No tax on tips for the self-employed

For self-employed individuals, recording and reporting tips work a little differently. If a business reports your compensation via a 1099 form, they may not account for tips separately, so you’ll need to document them yourself.

To make sure FICA taxes are calculated accurately, you’ll also need to include any tips you receive when estimating your quarterly payments.

As of the 2025 tax year (the first year this deduction could be claimed), self-employed filers calculate the deduction on the new IRS Schedule 1-A, in addition to their regular Schedule C.

There’s one limitation specific to the self-employed: The deduction cannot exceed your net profit from your tipped job.

Self-employed example for no tax on tips

Let’s look at an example scenario. Lisa’s main job is as a bartender, but she also has a side hustle delivering food. Both jobs are tipped, but as a bartender, she’s paid via W-2, while the food delivery is 1099 income.

Here’s what she earns in a given year:

• Bartending - $25,000, including $5,000 in tips
• Food delivery - $8,000, including $4,500 in tips

Lisa racks up $4,000 in mileage and other expenses for her food delivery job. This means her net profit for that job is $4,000, which is $500 less than the $4,500 in tips she earned from it. So for the food delivery tips, she can only deduct $4,000 instead of the full $4,500. Her W-2 bartending tips aren’t subject to this net-income limit, so she can deduct the full $5,000 there. In total, she’ll qualify for a $9,000 deduction, instead of the full $9,500 she made in tips.

Additional considerations for filing taxes on tips

The no tax on tips deduction certainly comes with tax-time benefits, but it doesn’t mean all taxes on tips disappear.

Employers will still need to withhold FICA taxes on all tip income, as they always have. That part doesn’t change. Federal income tax withholding on tips doesn’t change either; it’s calculated the same way it was before this deduction existed, all year, regardless of how much an employee earns in tips. The $25,000 cap only comes into play when the employee files their return and claims the deduction.

Additionally, the OBBBA doesn’t impact state and local taxes. For those who live and work in states, cities, counties, and townships that levy taxes on all income, tips will still be fully taxed.

Why is the "no tax on tips" only temporary?

The provision was included in the OBBBA as a temporary measure for the 2025–2028 tax years. It could be extended or made permanent, but that will require further action from Congress. If it’s not extended, it will expire after the 2028 tax year.

Does “no tax on tips” mean I don’t pay any tax on my tips?

No. The deduction only applies to federal income tax. Social Security, Medicare, and most state and local taxes are still withheld on every dollar of tips, no matter the amount. It also doesn’t change your paycheck during the year. The savings show up when you file your return and claim the deduction.

Find peace of mind come tax time

For small business owners and sole proprietors, implementing this tax provision correctly matters. Misreading the withholding rules is an easy way to end up with unhappy employees at tax time.

Accurately tracking tips requires up-to-date payroll and tax software. QuickBooks provides accounting, payroll, and tax tools to help you smoothly implement the no taxes on tips deduction. The QuickBooks platform gives you a way to manage tip and occupation reporting, W-2/1099 accuracy, and all your current and future tax benefits, deductions, and credits. Learn more about our accounting software today.